For those who would like to gift to loved ones, today may be the best gifting opportunity in 50 years.
The convergence of key factors make up these optimal conditions:
Historically low interest rates: Interest rates used in wealth-transfer strategies are now at a historic low, with the midterm applicable federal rate (AFR) at only .41% (3-9 years), and the long-term AFR at only 1.12% (9+ years) for August. This environment creates an opportunity with minimal tax consequences by using wealth-transfer tools that benefit from low rates, such as an intentionally defective grantor trust (IDGT), a grantor-retained annuity trust, and an intra-family loan.
Temporary increase in the gift and estate tax threshold: The current gift and estate tax exemption is $11.58 million per person. For a married couple, this means together they can give over $23 million to their loved ones. On January 1, 2026, this exemption will be cut in half to what will likely be less than $6 million. Additionally, many in Congress would like the exemption reduced even further, with proposals of $3.5 million. With an upcoming election, proactive planning is key to take advantage of this strategy while the exemption is still high.
Now, the next question is how to best transfer a trust? Clients may not want to give $1 million directly to his or her child or loved one due the risk of careless spending or a time of turmoil, such as divorce, bankruptcy, or a bad business deal. The good news is that clients can utilize various gifting trusts to both transfer wealth and protect it for generations to come.
One option is an IDGT which provides valuable protection and income, gift, and estate tax benefits. With an IDGT, an irrevocable trust is created for the benefit of an individual (“beneficiary”), who is often a loved one. Generally, the trust allows for the trustee to make discretionary distributions to the beneficiary, or standard income distributions are required at least annually. Placing the assets in an IDGT allows a client’s loved ones to benefit from the assets without giving them outright access.
The IDGT also brings income tax benefits, which creates additional wealth-transfer advantages. Specifically, the IDGT allows the trust assets to grow tax-free by having the client pay the taxes on the trust’s income, not the trust. This allows the assets within the trust to grow without the burden of paying income tax. The good news is that although your client is responsible for the income tax, the assets are removed from the client’s estate for gift and estate tax purposes. As a result, this allows the trust to grow tax-free, and all that growth is out of the client’s estate.
An IDGT can be funded in the form of a direct gift or by combining the sale of assets to the IDGT in exchange for a promissory note. Selling assets to the IDGT in exchange for a note is called an “estate freeze.” This happens because it swaps an asset out of the client’s estate at today’s value in exchange for a note that is of equal value. The key benefit is that all future growth of the assets is out of the estate and replaced with a note that has a nominal interest rate. If the assets sold to the IDGT produce a total return that is more than the interest rate on the promissory note, substantial wealth can be removed from the seller’s gross estate—gift- and estate tax-free. Based on today’s interest rates, that annual growth need only be between .41% and 1.12%, annually, depending on the term of the loan.
Another gifting option is an intra-family loan to fund assets purchased for a child or a loved one. For example, Marie wants to gift $1 million to her son to help him buy a home. Rather than using $1 million of her $11.58 million lifetime exemption, she structures it as a loan, at a 1.5% interest rate for 30 years, resulting in basically a family-funded mortgage to her son. This did not use any of Marie’s lifetime exemption, while also allowing her to achieve her goal of helping her son purchase a home. When structuring an intra-family loan, careful consideration must be made to ensure the loan is not considered a gift. The IRS assumes that a transfer of money to family is a gift, unless key requirements are met, such as charging a minimum interest rate at or higher than the AFR rates and ensuring the loan is commercially reasonable, which means payments are collected on time and as scheduled, and ensuring the loan is in writing, to name a few. When structured property, such an intra-family loan can be a powerful wealth-transfer tool.
An IDGT and intra-family loan are just two of many options that can be used to take advantage of this ideal gifting environment. If your clients are able to gift, talk to them today about the many solutions at their disposal, especially during this unique and opportune time.
Jeremiah H. Barlow, JD, is head of family wealth services for Mercer Advisors.